How to Sell Stock Futures to a Skeptic

Introduction:

A futures contract is the obligation to buy or sell the stock at a predefined agreed price at a later date in the future. The trading is perfectly organized by the exchange where all the counterparty risk is mitigated. The agreements have normalized particulars like a market lot, expiry day, and price of unit value, tick size, and method for settlement. The clearinghouse works as the guarantor of trades which is also associated with the exchange. The futures contracts are easily tradable as traders can transfer the contract to someone else at any point in time and get out of the agreement. For example, I have a positive view of the share of Reliance Industries and I wish to buy a whole lot of the share. Then I can buy the futures contract at any time and exit from the trade at any point in time depending upon my view on the underlying stock.

History of Stock Futures:

The Chicago Board of Trade (CBOT) facilitated the trading of futures contracts in 1865 in the US. The National Stock Exchange of India Limited (NSE) initiated trading in futures on June 12, 2000, which are based on the benchmark Nifty 50 Index. Throughout the most recent four decades, the derivatives market has seen an amazing development. Numerous derivative contracts were launched to trade over the world.

The objective of Stock Futures:

Futures markets have three main purposes. The primary is to empower hedgers to move price risk – asset price unpredictability – to speculators in return for basis risk – changes in the distinction between a futures price and the cash, or current spot price of the underlying asset. Since basis risk is normally not as much as asset price risk, the financial community sees hedging as a form of risk management and guessing as a type of risk-taking.

Benefits of Futures Trading:

• Hedging: Banks, Corporate, Investments firms, and governments all use the future to reduce their risk. The best example is the farmers who sell futures contracts to sell their crops on a future date.
• Margin Facility: Futures traders avail the facility of margin trading hence they don’t need to pay the full value of the contract. Normally, the margin percentage is between two to ten percent of the contract value.
• Liquidity: Futures trading brings more liquidity in the market as the traders can avail more number of shares with a margin facility. As a result, it brings liquidity to the market.
• Exchange-Traded: Mostly futures are traded on exchanges that provide the security to traders on counterparty risk.

Drawbacks of Futures Trading:                                                                     

• Expiry: Futures contracts have a certain expiration date which makes the future contract less attractive as the expiry date comes near. Also, the purpose of trading goes worthless as the position has to square off due to expiry.
• Volatility: Most of the traders take the position above on high leverages which makes it very difficult to manage in a volatile market. The need for an additional margin arises when the market even slight movement against the trader.
• Contract Size: The contract sizes of most of the futures contracts are large which makes it difficult for small traders to trade the desired underlying. As the small traders find it difficult to manage their risk at the time of volatility of such large future contracts.

Conclude:

As we can conclude from the above article, futures trading provides a wide range of benefits to traders then simply owning the underlying. However, there are some disadvantages too but the benefits surely can outweigh the drawbacks. Stock futures are vastly traded in the Indian stock market and people are making their living on trading futures. Traders most of the time trade future to hedge their cash positions and futures trading provides them an opportunity to profit from the falling in underlying stock price.

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